The Hong Kong Monetary Authority (HKMA) released today the classified loan ratio of the banking sector at the end of the 2nd quarter. The ratio was 1.97%, broadly similar to 1.98% at the end of March. As I have actually discussed on different celebrations, the classified loan ratio continues to deal with upward pressure, mostly driven by (CRE) loans. Pressures in global CRE (consisting of retail residential or commercial properties and workplaces) coming from the increase of e-commerce and remote operate in recent years are also apparent in Hong Kong. An increase in office completions has actually likewise led to continuing changes in the prices and leas of CRE in Hong Kong throughout the first half of 2025. Moreover, the high rates of interest environment over the previous couple of years has intensified the debt-servicing problem of business residential or commercial property designers and financiers, drawing market attention and raising concerns on the ability of banks to successfully handle the relevant danger exposures and monetary stability danger. I want to clarify these questions here.

Standing together with business

CRE costs and leas are presently under pressure from different factors, including interest rates and market supply and demand dynamics, which have actually caused a decline in the worth of loan security. Borrowers are not surprisingly stressed regarding whether banks will require instant repayment. To resolve this, the HKMA and the banking sector have repeatedly stressed that while the fall in local residential or commercial property rates and rents in the last few years have caused a down adjustment to the independent residential or commercial property evaluations, banks think about a host of elements when examining credit limits, including the borrower's credit demand, overall financial position and payment capability. Banks will not change a credit limit merely due to a change in the value of the residential or commercial property collateral.

There have actually likewise been misconceptions that property managers may decline to adjust leas in response to market conditions or perhaps leave residential or commercial properties uninhabited out of issue over banks requiring loan repayments. However, this does not align with banks' actual practices, and is also not sensible from a risk management angle. In reality, banks have actually earlier made it clear that they would not demand instant repayment exclusively due to a decline in rental income. This practical and versatile method shows banks' desire to stand together with enterprises, as well as their position and dedication to ride out difficult times with the neighborhood.

If a debtor in short-lived monetary difficulty breaches the regards to the loan covenant, will it result in the bank demanding instant repayment? The response is not always so. In practice, banks will first negotiate with the debtor, for instance, by adjusting the payment plan such as the loan tenor. Banks will take appropriate credit actions only as a last resort to protect the strength of their operations and the interest of depositors.

Protecting banking stability and depositor interests

The general public may therefore question if banks' support for business will come at the cost of banking stability and depositor interests. There is no need to fret as the HKMA has actually been carefully keeping track of the overall healthy advancement of Hong Kong's banking sector. We believe that the credit danger connected with CRE loans is workable. A considerable part of Hong Kong banks' direct exposures relating to regional residential or commercial property development and investment loans are to the big players with relatively great monetary health. For exposures to little and medium-sized local residential or commercial property developers and investors, consisting of some with weaker financials or greater tailoring, banks have actually currently taken credit threat mitigating measures early on, and the majority of these loans are secured. Besides, there is no concentration threat at specific debtor level.

A current media report highlighted the threats connected with CRE loans, with a specific focus on the accounting of banks' "expected credit losses". In truth, this is simply a calculation based on modelling for accounting functions. Loans categorized as "anticipated credit losses" do not always represent uncollectable bills, and therefore can not be used as a basis for an extensive assessment of banks' property quality.

Similarly, some other commentaries have actually focused solely on banks' classified loan ratios, which offers a somewhat minimal perspective. Hong Kong has actually gotten in a credit downcycle recently, having actually been affected by aspects like macroeconomic adjustment and rate of interest level. This has actually naturally caused an increase in the classified loan ratio of the banking sector. While the classified loan ratio has slowly returned to the long-term average of around 2%, from 0.89% at the end of 2021, the ratio remains far below the 7.43% seen in 1999 after the Asian Financial Crisis.

To gain a thorough understanding of credit quality, one can think about the following widely and long-used indications:

- The very first standard indication is the capital adequacy ratio: The healthy advancement of the banking sector includes building up capital throughout the expansion phase of the credit cycle, such that when the credit cycle adjusts and we see credit expenses go up and a deterioration in asset quality, banks would have enough capital to absorb the credit expenses. Banks in Hong Kong have adequate capital - the Total Capital Ratio for the banking sector stood at 24.2% at the end of March 2025, well above the international minimum requirement of 8%.

• The second essential indication is the arrangement coverage ratio: When evaluating non-performing loans, the vital concern is whether the relevant losses will affect a bank's core foundation. The provision protection ratio is utilized to evaluate if the arrangements for non-performing loans suffice. If a bank embraces sensible risk management and its arrangement coverage ratio remains above 100% after deducting the value of collateral from the non-performing loans, it means that the prospective losses from non-performing loans have actually been sufficiently shown in the bank's provisions. For the Hong Kong banking sector, arrangements are sufficient, with the provision protection ratio (after deducting the value of collateral) standing at about 145% at the end of March 2025.
• The 3rd indication is certainly financial strength: Despite the greater spotlight on non-performing loans, one essential criterion when examining a bank's strength is whether the bank can keep great monetary strength and its revenue model can be sustained after subtracting credit expenses. In this regard, Hong Kong's banking system recorded earnings development in the last 3 consecutive years even after taking into account the expenses for anticipated credit losses. The general pre-tax operating profit of retail banks increased by 8.4% year-on-year in 2024, and by 15.8% year-on-year in the first quarter of 2025, showing sound financial strength.
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  These three key indications reveal that Hong Kong's banking system is well-capitalised and has adequate provisions and excellent financial strength to endure market volatilities. In the face of a still-challenging macroeconomic environment, the credit risks faced by the banking sector have actually increased in recent years, yet the earnings designs of banks have not been impacted. I would also like to take this opportunity to clarify the earlier "bad bank" rumour. The facility of a "bad bank" is an extraordinary procedure which would just be thought about when banks have extremely major balance sheet issues. This is completely irregular with the current circumstance of banks in Hong Kong, which are operating in a sound manner with strong monetary strength.
  
  Hong Kong's banking sector has actually safely sailed through the 1998 Asian Financial Crisis, the 2008 Great Financial Crisis, the few years following the Covid-19 pandemic in addition to the 2023 banking turmoil in the US and Europe, demonstrating its strength and strength. Although the global financial outlook goes through numerous uncertainties and lots of markets have actually been seriously affected, the banking sector has remained supportive to customers in troubles and has actually been riding out obstacles with them, one crisis after another. This is a testimony to both the ability and commitment of the banks to weather challenging times with the community. The HKMA, together with the banking sector, will continue to do their utmost to support the development, upgrade and transformation of the real economy.